Should You Adjust Your W-4 Withholdings?

The New Form W-4 Employee’s Withholding Certificate

In 2020, the IRS released a new Form W-4, Employee’s Withholding Certificate to correspond with changes in tax law from the Tax Cuts and Jobs Act of 2017. 

The new W-4 employee’s withholdings form:

• Reduces the complexity of calculating withholdings and increases the transparency and accuracy of the withholding system.
• Relies on the same underlying information as the old Form W-4 design.
• Replaces complicated worksheets with straightforward questions.

While most workers aren’t required to file a new W-4, it may be a good time to re-evaluate withholdings. Choosing to have too little tax withheld can result in shock and frustration come tax time. On the other hand, there’s no benefit to letting the IRS hold your money completely interest-free should you have too much tax withheld. Ideally, you want your annual withholding and your tax liability to be close for the year, so that you don’t owe too much or get too much back when you file your return. 

The small investment of time making sure income tax withholdings are correct is well worth the effort. 

We’ve created this helpful reference guide for business owners to share with their employees. 

Reasons to Adjust W-4 Withholdings

Generally, you should look into filing a new Form W-4 any time you experience a major life change. Examples include:

Marriage, divorce or widowhood:

If you are newly married and filing a joint tax return, your taxes may be impacted as follows:

• If your spouse earns an income, your overall household withholding may increase.
• If your spouse doesn’t earn an income, your overall withholding likely will decline.

You may want to look into filing separately as it may better your financial situation. 

Divorce also can alter your household income. Alimony began receiving a different tax treatment starting in 2019 due to the 2017 Tax Cuts and Jobs Act. Alimony payments are no longer tax-deductible for the payer and recipients do not have to declare alimony as income.

For two years following the death of a spouse, the surviving spouse may be able to use the Qualifying Widow(er) filing status. Additionally, taxpayers who do not remarry in the year their spouse dies can still file jointly with the deceased spouse

Becoming a new parent:

The birth or adoption of a child adds a dependent to your household and lessens your overall tax burden. Additionally, under the 2017 Tax Cuts and Jobs Act, if you earn under $200,000 as a single filer or $400,000 as married filing jointly, you can include your qualifying dependent child on your W-4. This will account for the $2,000 Child Tax Credit. If you adopt a child, there’s potentially another tax credit available.

When your children grow up and move out, it is time again to readjust your withholding accordingly. 

Buying a home:

When purchasing a home, it’s important to update your withholding to lock in a tax break. Making this adjustment as soon as possible allows you to use your money on house and living expenses all year long rather than waiting to receive a refund.

Unique Increases in Wage Income

If your wages increased significantly, or you earned restricted stock units (RSUs) or other stock compensation, or a large bonus, withholding adjustments may need to be made. Similarly, earning money from side businesses or interest income can result in owing if enough taxes aren’t withheld throughout the year.

Second jobs:

Taking on a second job likely leads to an increase in income, which also could increase the amount of taxes owed. Increasing exemptions can help offset this change.

Spouse gets a new job:

Any substantial change of household income, either up or down, can put joint filers in a new tax bracket requiring modifications to tax withholdings. 

Household income drops dramatically or unemployment:

If you or your spouse are laid off and stay unemployed for a long period of time, there’s a good chance too much tax was withheld when you were working. When re-entering the workforce in the same year, you may consider re-evaluating your withholding to adjust for the downtime.   

You should also factor any unexpected large deductions or credits within a given year, including education credits, dependent care expenses, and charitable donations. In any of these situations, it is well worth the time changing the amount of employment tax withholdings. Keep in mind you can change your withholdings with an employer at any time. 

IRS Tax Withholding Estimator

If you’ve experienced a life change or are starting a new job, refer to the IRS Tax Withholding Estimator. Have your most current tax return handy as the new Form W-4 asks detailed questions based on your current and prospective tax return.

If your taxes are complex, it likely will take you more time to complete the new W-4 Form than it took to complete the old form.

For additional guidance regarding W-4 Tax Withholdings, please click the button below to schedule a consultation. See our Accounting & Tax Tips for additional business-related updates.